Inside IR35: what it means for your take-home pay

What "Inside IR35" means for your pay

When a contract is deemed "inside IR35" (also known as the off-payroll working rules), it means that for tax purposes, your working arrangement closely resembles that of an employee. This has a direct impact on how you are paid and the deductions made from your earnings. Instead of operating as a self-employed individual or a limited company director drawing dividends, you will be subject to Pay As You Earn (PAYE) Income Tax and National Insurance Contributions (NICs), much like a permanent employee.

The responsibility for determining your IR35 status generally rests with your client if they are a medium or large-sized organisation, or with the fee-payer (often a recruitment agency). If your client is a 'small' company, the responsibility for determining IR35 status and applying the rules reverts to your own limited company. From 6 April 2026, the thresholds for what constitutes a 'small' company have increased, meaning more companies may now be exempt from determining IR35 status for their contractors. A company is considered small if it meets at least two of the following: annual turnover not more than £15 million, balance sheet total not more than £7.5 million, and no more than 50 employees.

How your pay is calculated if you're inside IR35

The way your take-home pay is calculated depends on whether you work through an umbrella company or, in specific circumstances, your own limited company.

If you work through an Umbrella Company

Most contractors whose contracts are inside IR35 choose to work through an umbrella company. The umbrella company acts as your employer for tax purposes.

Here's a typical breakdown of how your contract rate is processed:

1. Client/Agency Payment: Your client or recruitment agency pays the umbrella company your agreed contract rate. This rate usually includes an amount to cover both your gross pay and the 'employer' costs.
2. Employer National Insurance (NICs): The umbrella company, as your employer, must deduct Employer's Class 1 National Insurance Contributions from the funds received. For the 2026/27 tax year, this is 15% on earnings above the Secondary Threshold of £5,000 per year (approximately £96 per week). This is a significant deduction that comes off the top of your assignment rate before your 'gross' salary is even calculated.
3. Apprenticeship Levy: If the umbrella company's annual pay bill exceeds £3 million, they will also deduct the Apprenticeship Levy at 0.5% of the pay bill, after applying a £15,000 annual allowance. This is another employer cost that is typically passed on to the contractor by being factored into the contract rate.
4. Umbrella Company Margin: The umbrella company then deducts its own administrative fee, known as the margin. This typically ranges from £15 to £30 per week or £60 to £120 per month (figures for illustration – check current rates).
5. Your Gross Pay: What's left after these deductions is considered your gross taxable pay.
6. Employee Deductions: From your gross pay, the umbrella company will then deduct:

• Employee's Class 1 National Insurance Contributions: For 2026/27, this is 8% on earnings between £242.01 and £967 per week, and 2% on earnings above £967 per week, after the first £242 per week is free of NICs.
• PAYE Income Tax: Calculated based on your gross pay and your tax code. For 2026/27, the Personal Allowance is £12,570. Basic rate tax (20%) applies to taxable income up to £37,700, higher rate (40%) up to £125,140, and additional rate (45%) above £125,140 (figures for England, Wales, and Northern Ireland).
• Pension Contributions: The umbrella company will auto-enrol you into a workplace pension scheme. For 2026/27, the minimum total contribution is 8% of qualifying earnings (between £6,240 and £50,270 annually), with at least 5% from your pay and 3% from the employer. The employer's contribution is typically covered by the initial assignment rate.

1. Take-Home Pay: The remaining amount is your net take-home pay.

If you work through your Limited Company (and the client is a 'small' company)

If your client is a 'small' company, the off-payroll working rules do not apply to them, and the responsibility for determining your IR35 status reverts to your own limited company (Personal Service Company or PSC). If you determine your contract is inside IR35, your limited company becomes the 'fee-payer' and must calculate a 'deemed payment'.

This means your limited company will:

1. Calculate the income received from the 'inside IR35' contract.
2. Deduct any allowable expenses directly related to that contract.
3. Calculate and pay Employer's National Insurance Contributions on the remaining amount.
4. Calculate and pay PAYE Income Tax and Employee's National Insurance Contributions on the 'deemed payment' as if it were a salary.
5. The remaining profit in your limited company can then be drawn as dividends, which are subject to dividend tax.

This scenario is less common for most contractors since the 2021 reforms, as the majority of clients (medium/large private sector and all public sector) are responsible for IR35 determinations.

Key deductions you'll see

Understanding these deductions is crucial for managing your finances when working inside IR35:

• Income Tax (PAYE): This is deducted from your gross pay at source, just like a permanent employee. The amount depends on your earnings and tax code.
• Employee National Insurance Contributions (NICs): Also deducted from your gross pay, contributing to your state pension and other benefits.
• Employer National Insurance Contributions (NICs): This is a significant cost that the umbrella company (or your PSC if you are the fee-payer) must pay. It's usually factored into the contract rate offered to you, meaning it effectively reduces the pool of money from which your gross pay is derived.
• Apprenticeship Levy: A tax on larger employers, which, like Employer NICs, is typically covered by the overall contract rate before your gross pay is calculated.
• Pension Contributions: Mandatory auto-enrolment contributions will be deducted from your gross pay, with an employer contribution also made from the assignment rate.
• Umbrella Company Margin: This is the fee the umbrella company charges for its services.

Common mistakes

• Not understanding all deductions: Many contractors only factor in Income Tax and Employee NICs, forgetting that Employer NICs and the Apprenticeship Levy are also effectively deducted from their overall assignment rate.
• Ignoring pension contributions: While mandatory, some contractors overlook the impact of pension deductions on their immediate take-home pay, even though they are saving for retirement.
• Not comparing umbrella companies: While the statutory deductions are the same across all compliant umbrella companies, their margins can vary. Always compare the overall service and fees.